Macroeconomic Features of the French Revolution Author(s): Thomas J. Sargent and François R. Velde Source: Journal of Political Economy, Vol. 103, No. 3 (Jun., 1995), pp. 474-518 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/2138696 . Accessed: 12/04/2013 15:49 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to Journal of Political Economy. http://www.jstor.org This content downloaded from 129.199.207.139 on Fri, 12 Apr 2013 15:49:56 PM All use subject to JSTOR Terms and Conditions Macroeconomic Features of the French Revolution Thomas J. Sargent University of Chicago and Hoover Institution, Stanford University Frangois R. Velde Johns Hopkins University This paper describes aspects of the French Revolution from the perspective of theories about money and government budget con- straints. We describe how unpleasant fiscal arithmetic gripped the Old Regime, how the Estates General responded to reorganize France'sfiscal affairs, and how fiscal exigencies impelled the Revo- lution into a procession of monetary experiments ending in hyper- inflation. I. Introduction Chronologyof Events This paper interprets the French Revolution from the vantage point of macroeconomic theories about government budget constraints. From 1688 to 1788, Britain won and France lost three of four wars. France recurrently defaulted on its debt and Britain did not. After We thank Ray Batallio, V. V. Chari, John Cochrane, James Conklin, Ethan Ligon, Colin Lucas, Rodolfo Manuelli, John Nye, Edward S. Prescott, Carolyn Sargent, Bruce Smith, John Van Huyck, Barry Weingast, David Weir, and members of the Research Department of the Federal Reserve Bank of Richmond for helpful comments on an earlier draft. We also thank the Hoover Institution, the Center for Economic Policy Research, Stanford University, and the National Science Foundation for financial sup- port. We would especially like to thank an anonymous referee of this Journal for decisive criticisms of two drafts. [Journal of Political Economy, 1995, vol. 103, no. 3] ? 1995 by The University of Chicago. All rights reserved. 0022-3808/95/0303-0007$01.50 474 This content downloaded from 129.199.207.139 on Fri, 12 Apr 2013 15:49:56 PM All use subject to JSTOR Terms and Conditions FRENCH REVOLUTION 475 1688, Britain had reformed its institutions to allow it to raise enough taxes during peacetime to finance debts incurred in times of war, and France sustained institutions designed to constrain the king's revenues. Modernizing forces in France wanted to eliminate govern- ment defaults and to smooth taxes and strengthen France's govern- ment by enhancing its access to capital markets. When King Louis XVI acceded to the throne in 1774, he pledged to honor the Crown's debt commitments, and successive governments initiated fiscal re- forms to facilitate raising and smoothing taxes. Yet reform was un- even, and the pressure not to default outran the government's ability to raise taxes. This led to a run-up of debt and interest payments in the years preceding 1789. Rather than default again, the king called the Estates General to accelerate the reform process.1 The National Assembly aggravated the debt problem by immedi- ately reducing taxes and by repurchasing many offices previously sold by the Old Regime. The government nationalized church properties and transformed the debt problem into a "privatization problem." It used the confiscated National Estates to administer a tax-backed money scheme by issuing notes acceptable at auctions of specific church properties.2 The government spent the notes for goods, ser- vices, and debt payments; auctioned some land on credit; and then burned the notes that were returned at the auctions. However, many notes remained in circulation, especially ones of small denomination. Specie left France for England and the rest of Europe. After two years of note issues, the supply of new currency rose to 70 percent of the pre-1789 stock of specie, and the price level rose about 30 percent. The tax-backed money scheme functioned adequately until a war broke out in 1792, which initially went badly for France. The government wanted more resources, so it divorced note issues from the land sales. The tax-backed money plan devolved into a fiat money scheme, causing real balances to drop and prices to rise quickly in early 1793 and threatening the base of the tax (the inflation tax) that was the government's lifeline. The Girondins bequeathed this situation to the Jacobins, who responded by imposing wage and price controls and a set of legal restrictions designed to boost the demand for assignats (a "guillotine-backed currency" scheme). As a result, real balances rose and the price level fell in the face of extraordinary issues of assignats, and the government raised immense revenues. In 1794, the war turned in France's favor, and the sense of emergency I Conklin (1993) asked: to those who trusted in prior arrangements, what is the difference between a "reform" and a "default"? Not much as far as we know. 2 "Tax-backed" because the land underlying this "land-backed" scheme was acquired by confiscation. This content downloaded from 129.199.207.139 on Fri, 12 Apr 2013 15:49:56 PM All use subject to JSTOR Terms and Conditions 476 JOURNAL OF POLITICAL ECONOMY diminished, making unenforceable the legal restrictions that had propped up the currency. The Jacobins fell in the summer of 1794, and the legal restrictions supporting the demand for assignats disap- peared along with the Terror. Then France experienced a hyperin- flation: real balances fell and prices exploded. The Directory adminis- tered the first classic hyperinflation in modern Europe until 1797, when it defaulted on two-thirds of the government's debt. Specie returned from England to France. In 1797, France returned to a specie standard and remained on it throughout the Napoleonic Wars. In 1797, Britain suspended convertibility with specie and did not reinstate it until 6 years after Napoleon had permanently left France.3 MacroeconomicTheories Coloring Our Observations Two macroeconomic ideas and three models of money inform our chronicle of events. Unpleasant arithmetic.-Government budget constraints and the arithmetic of compound interest impose restrictions on government deficits and debt. We use this arithmetic despite two difficulties. First, we have to assume that some commitment mechanism is available to support any sovereign borrowing.4 Second, when it is assumed that the government can borrow because it can commit to repay its debt, the government budget constraint alone imposes virtually no restric- tions on tax and expenditure processes (see Hansen, Roberds, and Sargent 1991). We obtain restrictions like those in Sargent and Wal- lace's (1981) "unpleasant arithmetic" only by arbitrarily putting an upper bound on the amount of government borrowing. Assertions that a fiscal crisis sparked the French Revolution hinge on positing a bound and on asserting that the French government was nearly hit- ting it. Sustainableplans. -Chari and Kehoe (1990) define a "sustainable" government plan to be one that enlists the self-interest of each group to implement its part when the time or the contingency comes for it to act. "Reform" of the Old Regime was difficult precisely because its institutions were largely sustainable, as a sequence of French finance ministers from 1775 to 1789 discovered. Tax-backedor asset-backedmodels of the demandfor currency.-These 3This summary is based on our reading of the historical record. Other readings include Stourm (1885), Marion (1914-21, vols. 1-4), Harris (1930), Aftalion (1987), White (1989), Bordo and White (1991), and Brezis and Crouzet (1994). 4 See Bulow and Rogoff s (1989) and Chari and Kehoe's (1993a) analyses of the severe limits on sovereign borrowing caused by the market's limited ability to punish sovereign defaults. See also Prescott (1977) and Manuelli (1988). This content downloaded from 129.199.207.139 on Fri, 12 Apr 2013 15:49:56 PM All use subject to JSTOR Terms and Conditions FRENCH REVOLUTION 477 models describe accompanying fiscal arrangements through which new issues of paper money cause little or no inflation. Legal restrictionsmodels of the demandfor currency.-These models study how a government can tax its citizens by forcing them to hold paper money it is issuing to finance a deficit; they describe circum- stances in which large new issues of paper currency cause less infla- tion than would be expected if people were voluntarily holding the currency. Classical hyperinflation models along lines described by Cagan (1956).-These models describe circumstances in which rapidly issu- ing a paper currency causes prices to rise even faster than the quantity of currency. We use these theories first to shape our descriptions and second to interpret how the revolutionaries explained their actions. We docu- ment how the revolutionaries used elements of these theories in the debates that shaped the Revolution. Our double use of theories re- flects the rational expectations hypothesis that parts of a time-series model are used by the people within the model to guide their fore- casts and decisions. We interpret inflation during the Revolution in terms of a procession of regimes in which the "if" parts of the three types of monetary models are approximately fulfilled.